Will the US Dollar Double Dip?
For the first time in over a decade, one US dollar bought less than 100 Japanese Yen. USD/JPY dropped to a low of 99.77 in the early European trading session as news of Carlyle Group’s potential failure hit the news wires. The hedge fund had trouble meeting its margin calls last week and now, it faces outright liquidation. This sent shock waves across the markets, triggering a sharp drop in stocks, bond yields and the US dollar. The biggest fear right now is the possibility that the Federal Reserve is losing control. Each new step that they take has been nothing more than a band-aid for a growing problem. If the Carlyle Group defaulted, lenders will want to recover their funds immediately, forcing a liquidation of any open positions in the market. This would lead to another wave of volatility in the bond, stock and currency markets and at this point, the Federal Reserve has no choice but to cut interest rates by 75bp. Fed fund futures are back to pricing in a 94 percent chance of a 75bp rate cut, up from a 64 percent on Thursday. However, if they really want to do the right thing and put an end to the pessimism and risk aversion across the financial markets, they need to give the markets a surprise by cutting interest rates 100bp in one shot. Retail sales last month was very weak. The rise in food and gasoline prices have been too much for most consumers to handle and as a result, they have cut spending to the point where the decrease in demand has offset higher prices, making overall gasoline sales negative in the month of February. Interestingly enough, the US dollar did not fall on the retail sales report. There were a bunch of rumors floating in the markets about why the US dollar and stock market recovered intraday, but we do not believe that any of these reasons are compelling enough to prevent a double dip in the US dollar. The Associated Press reported that the Senate has extended some of President Bush’s tax cuts, but this is limited. Standard and Poors indicated that the worst may be over for large write downs, but their main focus was on the severity of the subprime problems while rumors circulated about a number of different parties including the Fed, providing capital to Washington Mutual, the struggling mortgage lender. There are many reasons to remain bearish US dollars. Even though tomorrow’s consumer price report could confirm inflationary pressures that will not prevent the Federal Reserve from cutting interest rates by at least another 150 to 200bp. Therefore even if the dollar is rebounding off its lows today, we expect it to dip back below 100 against the Japanese Yen.

Euro Hits a High Above 1.56, SNB Keeps Interest Rates Unchanged
The weakness of the US dollar also drove the Euro to a new record high of 1.5626. Aside from Trichet reiterating his concern about excessive exchange rate movements, there have been no new comments from the ECB. Are they waiting for 1.60? Quite possibly. Back in 2004, when Trichet finally called the sharp rally in the EUR/USD brutal, the exchange rate appreciated 13 percent in two months. If we were to have an equivalent move in the EUR/USD now, the currency pair would need to hit 1.62. Inflation continues to be the ECB’s number one concern. Trichet also said this morning that if they failed to live up to their commitment of ensuring price stability, it would cause further turmoil in the financial markets and households would lose confidence. In other words, don’t expect them to stop the Euro from rising anytime soon. In addition to the US CPI report tomorrow, we are also expecting the Eurozone CPI numbers. Like the US data, they should be firm. Meanwhile the Swiss National Bank kept the target range of their 3 month Libor rate at 2.25 to 3.25 percent. They feel that even though the Swiss economy is still strong and inflationary pressures are mounting, slower global growth could take some of the steam of Switzerland’s economy. Their bias is neutral and for that reason, we expect them to remain on hold for the rest of the year.

Australian and Canadian Dollars Scream Higher as Gold Hits $1000 and Oil Hits $111
The Australian, New Zealand and Canadian dollars were the best performing currencies today against the US dollar. The strong rallies in these 3 currencies were driven by better than expected economic data and milestones in commodity prices. Last night, Australia reported a 36.7k rise in employment. The Australian labor market is the strongest in 33 years thanks to 16 straight months of job growth. New Zealand also reported growing consumer spending, which comes in stark contrast to the contraction in spending reported by the US today. Canada reported lower capacity utilization in the fourth quarter, but the third quarter numbers were revised higher. As for commodity prices, gold hit an intraday high above $1000 an oz while oil prices rose to an intraday high above $111 a barrel.

Japanese Yen Crosses Recover as Stocks Reverse Intraday
After having been down over 200 points, the Dow Jones Industrial Average staged a remarkable recovery. In reaction to the move, the Japanese Yen crosses have also rebounded, but other than AUD/JPY, NZD/JPY and CAD/JPY, all of the Yen crosses remain in negative territory. Although it may be tempting to buy into the carry trade recovery, we continue to warn against doing so. The financial markets are very volatile and traders are still risk averse. This should keep a lid on any meaningful recovery.

British Pound Hits 2-Month High
There has been a lot of action in the British pound today but none of it was related to the any UK economic data. The pound dropped to almost a 2 year low against the Japanese Yen, saw a strong intraday reversal against the US dollar and remained unchanged against the Euro. The only news out of the UK is a report that a UK hedge fund is looking to pump money into Washington Mutual.

Kathy Lien is the Chief Currency Strategist at FXCM.